European M&A soars, fueling record 2006 activity

MichaelWang

LONDON (MarketWatch) -- Europe's mergers-and-acquisitions market rebounded strongly in the fourth quarter on a fresh wave of energy and financial services deals, making 2006 the biggest year for corporate takeovers.

The red-hot market was fueled by a near tripling in the value of hostile takeovers, record private-equity buyout activity and broad corporate consolidation. Emerging markets - like Russia and the United Arab Emirates - also muscled in on what historically has been a the preserve of European and U.S. players.

Bankers said the outlook for 2007 was equally bullish - at least for the first half - and possibly even better than 2006's record year, if disappointing activity from a few contributors were turned around.

"(Ours) is markedly up from this time last year," noted Dag Skattum, co-head of global M&A at JPMorgan in London.

Announced deals targeting European companies totaled $1.40 trillion, including debt, for the year to Dec. 27. That's more than a third higher than $1.03 trillion in all of 2005 and comfortably above the previous record of $1.20 trillion set in 1999, according to data provider Thomson Financial.

A hectic fourth quarter clinched 2006's record-breaking year.

With just a few days left in the quarter, $424 billion in deals have been unveiled, the third-highest quarterly total ever in Europe. Among the biggest were Statoil's (STO) debt-included $32 billion agreed purchase of the energy assets in Norwegian peer Norsk Hydro (NHY) and Japan Tobacco's (2914.TO) $18.8 billion offer for the U.K. cigarette-maker Gallaher Group.

But, the U.S. has had an even more feverish final quarter with $521 billion in deals added, pulling it above Europe in the race for the world's biggest takeover market. In the year to Dec. 27, U.S. targeted transactions worth $1.53 trillion had been announced, according to Thomson Financial.

The prevailing urge to merge is underlined by a Morgan Stanley CDO survey of 100 major European chief financial officers, who rated M&A as their highest strategic priority for capital spending over the next 12 months. This compares with seventh place a year ago.

"This shift in priorities shows just how seriously CFOs are thinking of an M&A move," observed Gavin MacDonald, head of European M&A at Morgan Stanley in London. "M&A as a corporate growth strategy is pervasive."

As the hunt for corporate targets widened during 2006, it also led to a huge jump in hostile bids. Company boards increasingly pushed away initial takeover offers, often leaning on a rising stock market to justify rejections based on inadequate bid premiums. Almost a quarter of all European deal volume, or $343 billion in transactions, were hit with initial resistance by boards.

Private equity was just as omnipresent. Buyout firms launched takeovers worth $253.3 billion in Europe this year, up almost 50% from all of 2005.

But, despite the record year, these investment firms were often blocked by reluctant company boards from bigger deals. In terms of blockbuster deals, above $10 billion, buyout firms mustered just three in Europe, against nine in the U.S. - four of which came in the September to December period.

The underperformance in big-ticket deals in Europe comes against a backdrop of record fund raising.

Buyout firms raised $170 billion in the year to the beginning of December, up from $134 billion for all of 2005, according to Private Equity Intelligence, an industry research house.

In the last week before Christmas, $20 billion in buyout deals were announced in the U.S. compared to less than $1 billion in Europe.

"Europe has had a very strong year for M&A overall, but we've lagged the U.S. in terms of the size and acceptability of (private equity) deals," said Susan Kilsby, head of European M&A at Credit Suisse in London.

MacDonald of Morgan Stanley offers an explanation: "Boards here are fearful of the 'schmuck' factor," he said, referring to banking vernacular for being perceived as accepting too cheap a takeover offer. "It's a very big issue limiting buyout activity."

Buyout firms, or financial sponsors as they are also called, have had to shift strategies to do more business. Cash-return targets, once closer to 30% just a few years ago, now are slipping below 20%, sometimes markedly, said bankers. Investment modeling is widening to include cyclical businesses, such as airlines.

Said Adrian Mee, London-based co-head of European M&A at Lehman Bros: "Some financial sponsors have also looked further afield for opportunities - including Asia, Australia, South Africa and elsewhere."

Favorable Borrowing Environment

One of the main ingredients of the unprecedented M&A rally has been the exceptionally favorable borrowing conditions. It's not just low interest rates that have tempted companies to take on more debt, but the extreme competitiveness among lenders to put oceans of capital to work.

Borrowers are spoiled for choice in financing products and can easily recapitalize balance sheets through replacement borrowing.

With so much capital on offer, companies, and particularly private equity firms, have been tempted to take on more debt to overcome higher equity valuations in takeover situations.

"Clearly, liquidity is not an obstacle to doing deals in the market - rather suitable mergers and acquisitions targets are the problem," said McDonnell, S&P's chief European strategist.

The average purchase price for European leveraged buyouts in the three months to the end of November hit a record level of 9.4 times earnings before interest, tax, depreciation and amortization (EBITDA), according to S&P. This compares with levels closer to four times earlier in the decade.

Peter Tague, for one, is wary of the credit implications. "The credit providers are not sticking their heads in the sand," said the head of European M&A at Citigroup. "They are nervous. But while they are watchful, there is not a specific deal of substance to worry about at this stage."

Indeed, the encouraging credit outlook has laid the table for another M&A feast in 2007. Once again, companies will be tempted to jump-start their growth through substantial, if not transforming, takeovers; while buyout firms will adopt even more aggressive - and costlier - tactics to win new investments for their portfolios.

Emerging-market companies are also expected to build on their growing M&A predatory roles in the coming year, emboldened by a wave of initial public offerings, runaway stock markets and sky-high oil and gas prices.

"They aren't just buying football clubs," said Citigroup's Tague, referring to the celebrated 2003 purchase of the U.K.'s Chelsea soccer club by Russian billionaire Roman Abramovich and the advanced talks between Dubai International Capital, UAE-based state investment firm, and the owners of the Liverpool soccer club.

Instead, basic industries such as steel, telecoms and other sectors are likely to be on the shopping list. Some of those investors might also pursue a strategy of taking large minority stakes in European companies in order to spread investment risk, he predicted.

Earlier this fall, Lukoil (LKOH.RS), Russia's second-biggest oil company, negotiated a share-swap arrangement with Repsol YPF (REP.MC), according to bankers. Lukoil would have taken a 20% stake in the Spanish-Argentine oil company in exchange for handing over a 12% holding in itself. But, talks foundered during the final stages.

"We haven't seen petrodollars mobilized in M&A activity as much as they could have been considering the liquidity in this market," said Carlo Calabria, head of European M&A at Merrill Lynch in London. "This will change in 2007, as we are likely to see an increase in investment from the Middle East into Asia and Europe."

With just days before the end of the year, Morgan Stanley tops the rankings for banks having advised on the most European deals by value. It has advised on takeover transactions worth $486 billion in 2006, up from second in 2005, according to Thomson Financial. Morgan Stanley is followed in order by Citigroup, Goldman Sachs, 2005's number-one in Europe, JPMorgan and Merrill Lynch.

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